Jeremy Siegel cautioned investors a year before the Tech Wreck of 2000 and 2001 that the sector — especially internet stocks — was getting wildly overvalued.
Could the same thing be happening now?
While Siegel is not calling the next collapse in tech shares, he believes valuations of many such stocks are totally disconnected from their earnings. And he thinks the vast gap between growth and value stocks, which seems to cycle to extremes, will narrow as investors shift into more core, sound traditional businesses that have yet to fully recover but should as the economy escapes Covid’s grasp.
“Value shares are poised to rally in 2021,” says Siegel, “driven not only by the severe hit they took from the pandemic but because they offer the only compelling source of yield available anywhere.”
Jeremy James Siegel is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania in Philadelphia. He’s a senior investment strategy advisor at WisdomTree Investments, a global leader in exchange-traded products with $63 billion under management. And he comments extensively on the economy and financial markets for leading media outlets.
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Dr. Siegel received his Ph.D. in economics from MIT and is the author of the influential book, Stocks for the Long Run. Peter L. Bernstein, who authored the seminal work about risk, Against the Gods, described Siegel’s follow-up book, The Future for Investors, as a “masterful, provocative, fact-stuffed commonsense and creative guide to profitable stock-picking strategies.”
Where will the market be at the end of the year? Year to date, the Standard & Poor’s 500 is up 5%.
The S&P 500 may be up double digits.
So you have a benign outlook for the rest of the year?
I expect steady improvement across most statistics through 2020 and 2021. I think next year will be a very strong year for the market because of the build up of money supply balances. Many households have delayed weekend trips and normal spending — at restaurants, weddings, and vacations — so a lot of that money will be spent into 2021. And more people will return to work. But I believe business travel will be permanently down and much of that will not recover, and that’s going to smack commercial hotels. Tourist hotels will recover much faster as economies open up. I think, for example, Disney World will see record setting crowds. But convention halls, not so much.
How much will GDP have contracted by the end of 2020?
I think GDP for the year will be down by about -3%. Remember, the fortunes of major market indices aren’t directly linked to GDP because economic growth involves many small companies that don’t trade publicly.
How do you see the current divide between value and growth stocks?
We are at another time of extreme dispersion in returns between value and growth stocks, which we’ve seen several times before. The first time was in 1975 with the “Nifty 50 Stocks” when we saw a tremendous explosion in growth stocks. Then during the dot com bubble in 2000. Now, we’re seeing it again. Seems like this gap expands every 20 years.
We could be approaching a growth trap where investors are all too willing to overpay for leading tech companies. This could significantly impact the S&P 500. That said, tech shares could still appreciate in 2021, but at a slower rate than value stocks.
But the gap between growth and value feels like a perennial occurrence that never really closes materially even when extreme moments have passed?
Not true. Looking at the period between 1983 and the beginning of 2005 value outperformed growth. But since then, we’ve seen a tremendous burst in performance of growth versus value, especially in the aftermath of the financial crisis and the current Covid-induced technology boom. Value usually outperforms during recessions. But during the financial crisis and current recession, value stocks suffered because of the collapse of financial and real estate stocks, both of which are in the value category.
So why should one consider value this time around?
Think of it this way. The Fed is going to maintain low yields for a long time, and in my opinion, the only way investors are going to find good yields that will keep up with inflation is through value stocks — even with the cuts in dividends that have been going on during the pandemic. And remember after the financial crisis, which also saw dividends cut, we saw the strongest burst in dividend growth in history over the following decade.
Further, we’ve had this tremendous runup in growth stocks, which I believe has well outpaced their forward earnings growth rate. History suggests these shares will see a selloff. At the same time, we’ve had a remarkable pullback in value stocks due to the Covid crisis. These stocks that have been left behind during the recovery and will be the ones that will do better going forward. I believe economic circumstances argue for the return of value going forward.
Also note historically that a 20 PE ratio, which is where we are at now, suggests forward real returns of 5% for stocks. A 15 PE ratio suggests a 6.5% real returns. I don’t think going forward stocks are going to return quite the same as they have done in recent history. And compared to bonds, stocks will do much better.
Politically, if Biden is elected president and Congress is controlled by Democrats, we will likely see a heavier regulatory hand and likely higher taxes on big tech firms. Accordingly, these shifts could slow big-tech growth. At the same time, new stimulus spending should be a boon for traditional companies that fall largely in the value camp — like infrastructure, materials, and core industrials.
Lastly, there’s a misconception that automatic investments into the S&P 500 associated with 401(k) and other retirement plans benefit large growth shares more than value shares. The weighting of the new money that’s constantly flowing in is in proportion with the market’s current balance between value and growth. It doesn’t inherently enhance or hurt the returns of one versus the other.
What do you personally prefer to see companies do with their excess profits — buy back shares or increase dividends?
I like dividends very much. But buybacks give investors a tax advantage since the increase in share price generated by the buyback is only taxed upon the sale of stock.
Corporations often suffer from lousy timing when buying back stocks at peak values. Is there clear evidence that buybacks generate greater value for investors than the receipt of dividends — before or after taxes?
There isn’t any definitive research that points to higher stock returns when companies buy back shares versus when they pay dividends. Nor can we tell when a company does both whether it creates superior returns compared to doing one or the other. Yes, bad timing sometimes occurs when corporations buy back shares at high prices. But buybacks that occur over time actually average out and do boost earnings per share and raise share prices. Personally, I would like the firm to pay dividends first, but if it doesn’t, buybacks are an excellent way to create value.
Do you recommend that investors gain exposure to value through individual stocks or funds?
I think investors are more likely to enjoy superior returns targeting value indices and related ETFs than trying to pick individual stocks. I surmise, for example, financial shares should rally next year. But it may be more difficult to select the right bank or insurance companies to enhance returns over a solid sector ETF. I believe the search for dividends and the reopening of the economy next year will favor value stocks over growth shares.
Do you believe baby boomers, arguably the largest segment of investors, will be more focused on dividends and therefore push up value stocks?
Yes. This will be one of the factors that will help drive value back up. Value’s much lower PEs suggest more stability going forward than growth shares’ PEs, and value will benefit from greater dividend upside, especially when economic conditions stabilize.
What would you suggest is the ideal weighting today between value and growth?
I won’t give a precise percent allocation recommendation. But I would tilt toward value.
Might market volatility be the result of too much money flowing into indices?
While there could be a time when there is too much indexing, that will only be evident when active managers start to consistently outperform the market net of fees. I don’t see evidence of that. Accordingly, I am a big fan of indexing because very few people can consistently beat indices.
Do you believe the fortunes of major indices that are driven by the largest stocks will continue to thrive?
I believe investors will do better going forward if they don’t follow a capital-weighted index for precisely that reason. At WisdomTree, we’ve devised dividends- and earnings-weighted indices that we believe will outperform the broad-based capital-weighted indices. (Note: Earnings and dividend weights for each stock are determined as a percent of the earnings and dividends of the entire index.) I believe passive investing based on intelligently conceived indices is a sound way to invest.
Do you believe one’s entire portfolio should be passively managed? Should there be any discretion in asset management for the average investor?
I myself would rely on fundamentally-weighted indices going forward. As I mentioned, dividend- and earnings-weighted indices will give you a value tilt, which I believe will do well in the future. By and large, active investing has not produced better performance for most investors. However, as a hedge especially against anticipated inflation, I believe investors should be well served by adding up to 5% gold or precious metals to their portfolios.
A big issue that’s driving stocks is government-enhanced liquidity. How much money has the government pumped into the economy?
There are various ways to measure the liquidity boost government has provided markets. One key metric is the size of the Federal Reserve’s balance sheet, i.e., how much reserve credit has been provided. The figure has been substantial. Coupled with government spending, the total liquidity boost has been around $4 trillion as of late summer. This will likely increase further by year-end. All this has seen the M1 money supply rise four times faster between March and June of this year compared to the 12 months through September 2009 during the depth of the Great Recession.
Government spending and tax relief has been enabled by floating bonds that have been bought by the Federal Reserve. This increase in Federal Reserve credit is often referred to as Quantitative Easing. Private investors have not been needed to finance this debt because the Fed is buying this debt, and there is already high demand for U.S. government debt because of all of the uncertainty. Ten-year bonds are at 0.5% — the lowest in U.S. history. Thirty-year bonds are about 1%. But these longer-term yields will go up. (Editor’s note: since this interview was conducted, the rate on the ten-year bond has risen to 0.8% and the yield on the thirty-year bond has increased to 1.6%.)
Are you concerned that ultralow government interest rates may discourage investor demand for debt?
Understand the Fed pays the same price for government debt as other investors do. We’re dealing with something unprecedented — low inflation and real negative Treasury yields. This is uncharted territory. Low private demand for credit has also kept rates low.
With very loose interest rate policy that has produced negative real yields across the yield curve, we eventually might see debt fatigue, i.e., when investors start demanding more interest across the entire yield curve. This could happen if economic growth picks up and new bond issuances strain the debt market. There will likely come a time in the not so distant future when investors will demand positive real yields.
Aren’t foreign investors and governments also buying a lot of our debt as a safe haven?
Yes but the Fed has bought most of this year’s new debt.
How much liquidity have other governments and foreign central banks infused into the markets?
Many developed countries, led by the ECB and the Bank of Japan, have significantly increased liquidity. But we have offered the largest fiscal stimulus. We have reduced taxes and increased transfers to the public much more than other countries. Other countries have increased lending but not stimulus as much as we have done. The U.S. has put money directly into the bank accounts of business and consumers and ballooned our M1 money supply. Worldwide, we could be looking at an additional $8 trillion to $10 trillion in global market liquidity injected through various programs.
This begs the question: what’s the long-term impact of all this additional liquidity sloshing around the global economy?
I think all this stimulus will bring about strong economic growth in 2021 and higher inflation, especially in the U.S., where the stimulus has been the strongest.
A huge difference between the Great Recession and the current crisis is (1), financial institutions’ lending capacity was greatly impaired during the former, and (2), home owners lost trillions of dollars in home equity, which has not happened in this crisis. In fact many home prices outside of center cities have been increasing.
The stock market took more than five years to reclaim its former highs after the Financial Crisis. Now, it has taken the market just five months to return to pre-Covid levels. With real estate and stocks as consumers’ two largest assets, consumer spending and GDP will recover faster. But what will take some time is unemployment to recover. It’s my thesis that a lot of large firms that let go of people during the crisis will not rehire most of them.
With gold near $1,900, stock markets not far from record highs, unemployment still elevated and far from being in full recovery mode, and GDP falling substantially, does all of this make sense?
It makes total sense. Gold is high because of inflation fears. I think there’s going to be 3% to 5% inflation over the next two to three years due to the record increase in liquidity. I think moderate inflation is good for the stock market. This gives firms greater ability to raise prices. If they have debt, that debt will depreciate in value as debtors will be paying back such obligations in dollars that will be worth less than they are today. And interest rates are very low. I believe real wages will go up, especially as firms have gotten rid of less productive and less essential workers as business practices change in response to the new reality.
How is it possible for there to be double-digit unemployment while GDP rebounds?
Productivity increases will allow GDP growth to outpace employment growth. Firms are using Covid as an excuse to slim down, to eliminate senior people with severance packages, and others who weren’t productive. These firms will be much leaner and meaner going forward.
Firms are also reducing costs through less business travel and will experience a decline in office rental costs, especially as leases expire. And landlords will likely be forced to renegotiate office rents downward. For some firms, real estate costs might go down by as much as 50%.
What you’re ultimately suggesting is a further bifurcation of the haves and have not.
That’s correct. The pandemic has exacerbated the differences in wealth and income.
How do we address that?
This problem existed well before Covid. Simply put, we haven’t been sufficiently training people for 21st-century jobs. The pandemic drives this point home. Many workers simply don’t have the skill set to really thrive in today’s economy — especially the new, leaner version we’re entering into.
If you anticipate inflation will rise by 3% to 5%, what does that mean for lending rates?
The Fed will keep overnight rates down. Since bank lending rate spreads above the Fed rate have historically been around 3%, I expect shorter-term lending rates to remain low. Longer-term rates will rise along with longer-term Treasury yields.
Will residential urban real estate continue to suffer?
I believe that residential urban real estate will snap back. Although office demand will decrease, many young people will still like to live near restaurants, the arts, and communities that do not require cars. As fears of the pandemic wane, people will return to the cities. But commercial space will remain impaired.
What are the implications on structured credit vehicles, which are highly levered to real estate, especially commercial property?
Investors in such vehicles, particularly connected to malls and offices, will suffer.
Will those losses be sizable enough to impact the stock market?
The Dow Jones total return REIT Index is down about 10% year-to-date through mid October. REITs connected to commercial and technology-oriented warehousing have done very well; those connected to malls and offices have performed poorly. But I don’t expect these losses to affect the broad stock market.
Banks have certainly upped their loan loss provisions. But I believe they are adequate to cover their exposure. Still, financials are down 18% year-to-date, the second worst performing sector after energy, which has collapsed by nearly 50%. However, banks are still able to lend, and I expect this to have a positive impact on economic recovery.
I’ve noticed anecdotally in Manhattan that many small businesses are not getting any help from landlords.
That doesn’t matter much for the overall recovery. Many of these businesses will fail and new businesses will eventually take over. There will be attractive rental opportunities for both commercial and retail businesses.
If cheap borrowing costs help sustain poor companies when the market would otherwise have cleared them off the table, aren’t you concerned about the loss of moral hazard and preservation of firms which should not be around?
I see no widespread evidence of that. Some businesses might linger too long, but they will eventually be replaced by others that are more profitable.
What are your thoughts about international investing at this time?
There is a place for international exposure because I believe U.S. stocks have run excessively ahead of EAFE (Europe, Australasia, Far East) and emerging markets. So investors should not abandon their foreign exposure. I do think a significant chunk of your total equity portfolio should include emerging markets, Europe, and Japan. Think 60% U.S., 25% EAFE, and 15% Emerging Markets — with foreign exposure unhedged to currency shifts.
How does Europe look at this moment?
European stocks are currently cheaper by valuation than U.S. stocks. And with the amount of liquidity that has been added by the Fed, I believe we are likely to see the dollar continue to weaken, which will make foreign investments, including in Europe, look attractive. The weaker the dollar gets, the greater foreign investments are worth to U.S. investors. I think we might see the dollar drop another 5% or 10% against major and emerging market currencies over the next couple of years, especially if U.S. inflation exceeds foreign inflation. This would point investors to unhedged foreign stock indices. U.S. investors could then get a double benefit if foreign stock prices rise in local currency terms.
Do you believe interest rate differentials between major countries are going to increase?
That is likely. But I don’t think that’s going to draw foreign money here because I think those higher rates will be accompanied by rising inflation, which lowers the attractiveness of the dollar.
Do you think this crisis threatens the euro regime?
No. The euro regime will hold. Political agitation to get out of the euro has actually decreased since the pandemic.
What impact do you think the upcoming national elections will have on the market?
Short term, it adds uncertainty. If we have a clean election and a clear winner, I believe the market will do better if the Republicans hold the Senate and we don’t see substantial rises in taxes. That said, I think a Biden presidency will throw a lot of money at unemployment, job training, infrastructure, and I think all this will bring more stimulus than what we would get from four more years of Trump. This additional spending will most likely exceed the amount of taxes a Biden presidency and Democratic Congress might raise. Still, a Democratic sweep could pause the market rally. If Trump wins, the fear of higher taxes will be gone, but there will still be fear of escalating trade uncertainty. There’s no clear case that one party will be better for the stock market than the other. But I believe the best case for the stock market would be a Republican Senate.
Are you concerned about the extraordinary amount of debt the government is piling up?
There’s no pressure to cut the debt until interest rates rise to the point when they start hurting the economy. I’ve been saying this for the past 10 years. This situation will not occur for quite some time.
If we wait until then to do something about the debt, might it be too late to stop a public debt crisis and all its related damage?
No. When rates rise sufficiently to negatively impact the economy, Congress will then cut expenditures and raise taxes.
You don’t believe we need to bring down our massive debt to help the government deal with the next crisis?
No. That argument was also made a year ago. We have subsequently had the Covid pandemic and there was more than enough room in the debt markets for the government to pass the stimulus plan.
Do you believe the Trump tax cut during the boom was a macro mistake?
Not necessarily. The biggest long-term stresses on the budget are Medicare and Social Security, not the Trump tax cuts. Nevertheless, we are eventually going to have to address these entitlement programs.
Are you concerned we’re moving into an economic scenario that’s comparable to what set off Japan’s long-term stagnation where the country has had low interest rates, high debt, and slow growth?
There are two things that distinguish the U.S. economy from the Japanese economy. First, Japan has the oldest population of any developed market. It has a decided tilt towards non-working elderly that is increasingly supported by a smaller percent of the working population. Second, while Japan is a modern, sophisticated society, its economy is less innovative than ours. Just think of Sony. Back in the 1980s, it was a tech leader. No more. Thinking outside the box is the U.S.’ strongest suit. This is how the U.S. will escape the trap that has held back Japanese growth.
And how will Europe fare?
I think Europe shares some of the same demographic characteristics of Japan. But Western culture in Europe is more innovative, yet it still trails the U.S. on that front.
Thank you, Jeremy.
Eric Uhlfelder has covered global capital markets and asset management for the past 25 years, authored “Investing in the New Europe,” published by Bloomberg Press, and is a recipient of a National Press Club Award.
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